contractor conversion

clock August 13, 2021

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Everything You Need to Know About Contractor to Employee Conversion

You have many possible reasons for wanting to convert one of your contractors into an employee. Employees are often more motivated to work toward your company’s goals. They are a long-term investment whose growing knowledge and skills are an asset to you and your other workers. You have more control over their training, schedules, and work processes. However, when you’re ready for a contractor conversion, the process may be more complicated than you expected.

Find out what you need to know for a successful employee conversion. 

Contractor Vs Employee

A contractor to employee conversion is necessary if changes in the worker’s job specifications or relationship to your business would change their classification status.

The IRS uses three categories to determine the difference between contractors and employees:

  • Behavioral control, meaning that the business can control and direct the employee’s work
  • Financial control, which is control over the financial and business sides of the worker’s job
  • Relationship between the worker and the business

The IRS takes worker classification seriously. If you classified a worker as an independent contractor when that person should have been an employee, you are responsible for paying the applicable employment taxes. However, if you had a reasonable basis for the classification, you may be able to avoid paying these taxes.

Some businesses are eligible to reclassify their contractors as employees under the federal Voluntary Classification Settlement Program (VSCP). You get partial relief from having to pay federal employment taxes.

In general, the IRS considers workers to be employees unless you can prove otherwise. If you need to change a worker’s classification, don’t delay. You’ll avoid potential problems with the IRS.

Notify the Worker

You need to notify the worker of your decision to make the contractor to employee conversion. Ideally, you would have a discussion about the terms of employee conversion. The worker is always free to refuse your proposal.

You should also notify the worker in writing. A written message gives you documentation of the notification. Be sure to make note of the date you notify the worker. If you mail the written notice, use a certificate of mailing or certified mail, so you have proof that you sent the letter.

Access to Benefits Options

You’ll need to give your new employee the same benefits options as your other employees. Paid vacation days, paid sick days, access to a retirement plan and health insurance are some examples of these benefits. Give the employee any necessary forms and paperwork.

Managing benefits after a contractor conversion may have additional complications. Retirement plans can be particularly complex. Be sure to contact your plan provider or administrator if you have questions.

Establish a New Employment Contract

You should formally end any written contract you had with the worker as a contractor. You can then establish a new contract with the worker as an employee. An employment attorney can advise you if you’re not sure what you should include in an employee contract.

Labor Regulations

You must comply with labor regulations from the federal, state, and local governments. Laws govern many aspects of the employee-employer relationship, like the payment of wages or salary and overtime.

You need to report all newly hired employees to a designated state agency. If you have employees in multiple states, you can either report new hires to the states where they work or choose one state to report all of your new hires.

Labor laws and regulations are very detailed, and following all of them can be complicated. If this contractor conversion is your first, you may want to consult a legal professional.

Payroll Taxes

Your tax obligations change when you make a contract-to-hire conversion. You didn’t withhold taxes from contractors’ pay, and you reported how much you paid them on a 1099-MISC. You have additional responsibilities for employees.

Income Tax, Social Security, and Medicare

You need to comply with payroll tax regulations for employees. You and the employee have to fill out an I-9 to verify the employee’s eligibility to work in the US. The employee should fill out a W-4 Employee Withholding Certificate for federal income tax. If state and local income tax withholding applies, the employee needs those forms as well.

In addition to income tax withholding, you have Social Security and Medicare requirements (FICA taxes). You withhold half of the employee’s Social Security and Medicare tax obligation from the employee’s salary. Your business pays the other half.


You’ll need to pay unemployment insurance and workers’ compensation insurance for employees. Payments into the unemployment insurance system help people who have lost their jobs. The system replaces part of an individual’s wages while they look for a new job.

Workers’ compensation insurance provides wage replacement and pays medical bills for an employee who is injured while working. An employee who accepts these benefits gives up their right to sue you for negligence. The requirements for workers’ compensation coverage can vary depending on your state, your industry, and the size of your business.

Workers’ compensation insurance is important to protect you, your business, and your employees. Be sure to find an experienced provider who will ensure you have the right coverage.


Instead of a 1099-MISC, you’ll give each employee a W-2 to report their income and how much tax you withheld and contributed on their behalf. Employees use the W-2 to file their taxes. You’ll also send a copy of each W-2 to the Social Security Administration.

Getting Help with Your Contractor Conversion

You don’t have to manage your contractor conversion by yourself. One area where you can take advantage of a partner company’s expertise is your workers’ compensation insurance. National Workman’s Comp Solutions gives you affordable quotes from professional employer organizations in your industry.

In addition to giving you quality options for your workers’ compensation insurance, we can manage your payroll and HR. Outsourcing these complex operations lets you focus on growing your business.

Contact us to find out how our workers’ comp, payroll, and HR resources can give your business a competitive edge.

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